The SEC and the first amendment

David Rivkin and Bruce Brown:

It took Watergate's political meltdown to bury one dangerous and intellectually creaky restraint on press freedoms. In the spring of 1974 Richard Nixon enthusiastically supported the idea of forcing newspapers to print responses from candidates for office criticized in their pages. Subsequently the Supreme Court held such "right of reply" statutes to be unconstitutional.

"The choice of material to go into a newspaper" belongs to its editors, the Court said. It added that the threat of steep fines for violating the law would steer the press to the "safe course," thus reducing the amount of election coverage precisely when it was most needed. A political crisis was no time to be selling the virtues of government intrusion into the nation's newsrooms.

The same logic applies to economic crises. Today the marketplace urgently needs the press and independent analysts to dig for truth without government second-guessing. Nevertheless, early next month the Securities and Exchange Commission will be arguing for the first time to a federal appeals court that it can regulate publishers.

The SEC's weapon is Section 10(b) of the Securities Exchange Act of 1934, the general anti-fraud provision that prohibits false statements made "in connection with the purchase or sale of any security." Section 10(b) has, appropriately, been applied to various players in the securities business -- issuers, brokers, dealers, underwriters, traders and professional investment advisers. But no court has ever found Section 10(b)'s "in connection with" requirement satisfied by publishers who do nothing more than write about stocks.

The SEC crossed that line by suing a stock-market newsletter for damages and injunctive relief in a case that has now dragged on for five years. The government's complaint is based on a conversation between writer Porter Stansberry and a source at a public company. Mr. Stansberry believed the source had disclosed that an important contract for the company would soon be approved, and he published the information in a report offered to subscribers of his newsletter, Porter Stansberry's Investment Advisory. The SEC argued that the source made no disclosure to Mr. Stansberry and that his error caused short-term losses to subscribers who bought his report. (The contract approval followed a few weeks later.)

Absent is the only factor that would have explained SEC involvement: stock trading by the writer in the subject company. The government should intervene when day traders, masquerading as disinterested analysts, profit from their own sales. But the SEC has no more business penalizing a writer who simply covers the markets than the Food and Drug Administration has in regulating a cookbook publisher because an official questions the nutritional content in a meatloaf recipe.

The law rightly imposes fiduciary and disclosure obligations on those who conduct business on the nation's stock exchanges. Now the SEC is threatening to treat news pages and the recommendations in financial newsletters the same as a stock prospectus from a Fortune 500 company, or the SEC filings of a corporate raider. A statement from a newspaper or an academic about a public company that the SEC claims to be false (and made recklessly) could lead to liability.

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Nearly 40 years ago I had this debate with a professor teaching securities law whose position was that the SEC could regulate what the media said about securities. I agree with Rivkin and Brown that this is not an area where they should be able to regulate commercial speech.

If the writer had and interest in the prospects of the company that would be an important disclosure, but otherwise he is just reporting what is news and it is up to the company representative to make sure that what he tells a reporter is accurate and he and the company can be held liable for inaccurate and misleading information.

My recollection of the debate is that it was unusual because of my unwillingness to back down and it went on for a good portion of the class. I am sure the professor would have been surprised to learn that I had a career in the securities industry after that encounter.